Settlement Finality in Blockchains: PoW vs PoS

In this post Shawn explains the concept of Settlement Finality in blockchains. He then goes over finality in proof of work and finality in proof of stake, resptively.

Settlement Finality

Settlement & Finality – often heard and often misunderstood. Newer blockchains boast about their speed to "finality". But does that really mean? What is Settlement Finality?

Put simply – all transactions (daily transactions, security trades etc) have to be "settled" to be considered "final". Hence, the term Settlement Finality.

In our daily transactions, settlement banks handle the 'finalisation' of our transactions. They are the middle-man. And we pay them for the privilege. However, a blockchain manages it's own settlement finality. It does not require a middle man. This is one of the reasons why blockchain technology is so revolutionary.

Middle-men are used in the traditional systems to ensure that transactions have finality. A blockchain, on the other hand, uses a consensus method like Proof of Work or Proof of Stake to reach finality.

But before we go any further, let's quickly describe what finality really means.

Settlement & Finality: What Is Finality?

Finality:Finality simply refers to the idea that the occurrence of event is “final” and “permanent”. You cannot undo this event – it has occurred, and will remain ‘occurred’

An Example: A simplified example of Finality would be your age. Once you turn 18, you’re an adult – and you will remain an adult forever. You can be certain in the ‘finality’ of that. No one can go back and change that event. (Unless time travel is possible, and they murder you before you’re 18)

However, achieving finality with financial transactions is actually easier said than done. We tend to equate "extremely difficult" to "impossible".

To understand, let's explore settlement finality in blockchains and banks a bit more.

Settlement Finality: Blockchain vs Banks

In the finance, people & businesses want to be certain that their transactions are "settled & final".This Settlement Finality is traditionally handled by settlement banks

Businesses – small or large – face issues with finality of payments quite often. A consumer can attempt to reverse his payment made via VISA or PayPal. In these scenarios, settlement finality conflicts are handled by the middleman.

However, middleman-solutions are always going to be a point-of-weakness for finality. What if people in key positions are bribed? What if centralised servers are hacked? In a centralised solutions, there's always a chance that finality is reverted. Each intermediary will pose a risk point.

Comparatively, a blockchain uses no intermediary. It achieves finality via it's consensus method. Notable consensus methods are Proof Of Work and Proof of Stake. Both of which eliminate several weaknesses of centralised systems. However, neither of them achieve true finality. Finality will always be probabilistic (i.e there's a chance – however small – that a transaction can be reversed)

First, let's go over finality in proof of stake and proof of work.

Settlement Finality: Proof of Work & Proof Of Stake

​​Finality in PoW and PoS are achieved in different ways. In Proof Of Work, the hash puzzle plays a key role in determining when a settlement is reasonably 'final'. Proof of Stake uses a raffle system and economic incentives to arrive at finality (you could call it economic finality)

Finality in PoW

Blocks in Proof Of Work age well – the more hashpower used on future blocks, the more resilient the older blocks are to attacks. Why? Cause if someone wants to reverse a payment, he has start a new chain beginning at the old block. He has to then try to outpace the current chain. He will have to ensure that his chain is the longest chain. The only way he can do this is by consuming A LOT of electricity. This is why we wait for “Confirmations”. Each confirmation represents a block. Anything over 6 blocks gives us reasonable finality.

Finality in PoS

Casper’s Proof Of Stake uses a sorta raffle-system to facilitate finality (and other security elements too.) People who want to validate blocks deposit their Ether into a pool. This pre-registering all the possible validators. Validators are then asked to declare finality at certain intervals. Essentially saying: “I agree that every transaction/event up until this point is legit”.

If at least, ⅔ of the validators make a claim – you have reasonable finality.

Notice how I said “reasonable finality” for both – Proof Of Work and Proof Of Stake. This is because finality is always going to be probabilistic! To understand this, we have to dive a little deeper – but I’ll try to simplify.

Blockchain Settlement Finality is Probabilistic

I say "reasonable finality" because finality in proof of work and proof of stake are still not truly "final". Technically, a settled payment can still be reversed. It may be improbable – but not impossible. Let's go over some of the ways:

A 51% attack can lead to a reverse payment in Proof of Work–regardless of block age. While this is difficult, it’s not impossible – it’s improbable. ​

In Proof Of Stake, we have the Nothing At Stakeattack – which again is improbable, but not impossible. (I explained Nothing At Stake just yesterday actually) Even with punitive penalties implemented - slashing - we have the improbable chance that a bunch of validators are willing to burn their own capital to hurt the network.

Finally, even our current centralized solutions don’t have finality because they can alwaysbe hacked, burned down, gun-to-the-headetc etc. Perfect finality is probably impossible. There are too many external factors outside of the system that can remove finality.

Final Thoughts

No system is perfect – yet. A bank can be hacked. Proof of Work is subject to a 51% Attack. Proof Of Stake is subject a 1% Attack. However, blockchains and distributed ledger technologies have come a long way in increasing the likeliness of finality.